Creative destruction and the Holmdel Lab

According to IEEE Spectrum, the Holmdel Laboratory, the centre of Bell Labs in their heroic age, is probably going to be knocked down. The structure was once home to the world’s best privately-run research organisation, with some 6,000 scientists and engineers and a library second to none. The work carried out there included the development of

the transistor, the laser, the solar cell, the light-emitting diode, the charge-coupled device, fiber optics, satellite communications, touch-tone dialing, cell phones, modems, microwave communications, local area networks, UNIX, C, and C++..

Southampton University would probably dispute the fibre claim, as they invented the process of making the cables industrially (indeed, the original equipment was lost in a fire last year), but anyway. This was where it all began.

The building was nothing if not suited to this role. The V&A’s big Modernism exhibition this year is titled “Designing a New World,” and that was precisely what Bell Labs was doing. So they hired Eero Saarinen to build them this..

No wonder it impressed the hordes of postgraduates it sucked up like a black hole. So, beyond a decent concern for geek heritage and architectural preservation, what am I drivelling on about this for? There was a reason why AT&T could afford to fund all this research, as detailed here. As the monopolist of all the telephones in North America, each and every phone call paid a few cents towards the R&D budget, a revenue stream that could be relied upon as few other businesses.

This brings us to an interesting point. The great Viennese economist and Harvard prof Joseph Schumpeter’s distinctive contribution to economics is his concern for dynamic economics-the standard models usually assume one point in time and no technological change within the model, or else the convention of two moments in time, t-1 and t. Schumpeter argued that the reason there appears to be a long business cycle is that technological progress is not constant, or rather, it’s not evenly distributed even if it advances at a steady average speed. There is a breakthrough, which spawns dozens of new opportunities and leads to a period of prosperity. Then, as the diminishing marginal returns set in, the possibilities are exhausted and the technology becomes more baroque, growth stagnates and inflation rises. Eventually, there is a new discovery.

This is obvious, if not trivial. But the key insight of Schumpeter’s was the implication of this for competition and the theory of the firm. Traditionally, it is assumed that firms compete primarily on price, and that allocative and productive efficiency are maximised in perfect competition. Schumpeter stood this on its head, arguing that innovators are motivated by the possibility of becoming monopolists and making supernormal profits. The necessary check on them was the possibility that someone would discover something sufficiently new to destroy the monopolist. This feedback loop he named the theory of creative destruction, a phrase that has far outrun its initial use – it’s commonly used as a snotty term for classical competition, or even assumed to mean that capitalism requires war. In fact, it means that in principle moving towards perfect competition may actually decrease long-term total factor productivity.

Bell Labs is exhibit A, of course. AT&T’s monopoly profit funded the new electronic future, and the Bell Labs management made a deliberate policy of openness towards the competition, helping (for example) others to learn the technique of transistor manufacturing. It could also hardly be faulted for a lack of enterpreneurship – for example, when it was working on the first communications satellite, it came up with some radical answers to NASA’s unwillingness to provide it with a rocket.

Eventually, though, those same technologies helped to destroy AT&T. The mothership-the telecoms company that was, after all, the point of all this research activity-showed all the signs of a jealous, conservative, dull monopolist content to sit on its monopoly..

Although electronic switches based on solid-state components had been developed by 1959, AT&T didn’t introduce the first digital switch into the Bell System until 1976. And electronic switching was still being gradually rolled out well into the 1980s, when AT&T’s monopoly on telephone service came to an abrupt end. The much more rapid introduction of digital switches by MCI and Sprint probably contributed to AT&T’s downfall.

And even though Bell Labs and Western Electric developed most of the underlying silicon technology required for the integrated circuit, which eventually became the guts of the electronic central-office switch, AT&T wasn’t in on its creation. The upstarts Fairchild Semiconductor and Texas Instruments, focused as they were on miniaturizing electronics for their military and aerospace customers, led the way instead. Here again, AT&T engineers probably contributed to the lapse by insisting on high-performance discrete components built for 40-year lifetimes in the Bell System. There was no great drive for miniaturization in the system, acknowledged Ian Ross, the president of Bell Labs at the time of the breakup. “The weight of the central offices was not a big concern,” Ross said.

It was government action, in the end, that killed the monopolist. But the point remains. Schumpeter was almost certainly right that a trade-off exists between static and dynamic efficiency, but he could never operationalise the principle. The argument that such-and-such a corporate privilege must be retained in order to promote long-term R&D is as common a self-serving excuse as retailers blaming the weather for poor sales. (National telecoms operators are especially addicted to it.)